A majority of large and medium sized corporations provide health care benefits for their retired employees. Up until the late 1970's employers treated retirement benefits as an alternative method of compensation. The retiree health care cost was an added feature of the corporation's pension benefits since many companies correctly assumed, at that time, that the actual cost would largely be borne by Medicare. With health care costs soaring (rising faster than the Consumer Price Index for 10 years in a row) coupled with increased life expectancies, early retirement and the consistent drop in the portion of costs covered by Medicare, that initial assumption of a margin between the covered costs and Medicare payments has virtually disappeared. In fact, the narrow margin has turned out to be an enormous expense.
An additional change has further compounded the financial burden for corporations. In the fall of 1990, the Financial Accounting Standards Board (FASB) promulgated accounting standard 106 reflecting FASB's belief that retiree health care is just another form of deferred compensation and should be reflected in corporate balance sheets and income statements similar to the way FASB treats pensions. In essence, FASB required that unfunded active health care costs be reported as corporate liabilities and that the accrued benefits be charged to corporate earnings. The impact of FASB 106 will create additional and sometimes enormous liabilities on corporate balance sheets and have a detrimental effect on corporate net worth.
To contend with looming liabilities and the impact of FASB 106, corporations recently began to attempt to reduce their health care obligations to a manageable level. Their efforts appear largely unsuccessful.
Some corporations proceeded to fund plans through tax-exempt trusts known as Voluntary Employee Beneficiary Association (VEBA) trusts under Section 501(c)(9) of the Federal Tax Code. Following the 1984 Tax Act, however, certain restrictions were placed on VEBAs including the limitation on tax deductible pay-ins. For example, inflation could no longer be taken into account for calculating funding levels and certain investment earnings on VEBAs were taxable. As a result, many corporations that previously used VEBAs as vehicles for funding post-retirement health care, halted, or severely curtailed, their contributions.
Another approach used was funding a 401(h) account as part of the employer's pension trust. The 401(h) account is a retiree health account placed within a pension trust. The 401(h) account, however, also has severe tax limitations. Companies are only permitted to funnel 25% of their contributions to the pension plan into the health care account. The 25% limitation is not sufficient to reduce a corporation's increasing liabilities.
Other solutions include re-designs of existing post-retirement plans to reduce expenses and decrease overall liabilities. A drawback with re-designs is that they often result in litigation or resistance by employee associations and/or unions.
A further option to fund health care liabilities is through Corporate-Owned Life Insurance (COLI) plans. COLI plans generally work as follows: a company buys life insurance on workers and retirees naming the corporation as beneficiary; the cash value of the policy then builds as an asset. Since COLI is life insurance, the interest on amounts borrowed from the life insurance plan (to offset the retirement cost) are tax-deductible. In addition, the actual build-up of cash in the life insurance policy also is not taxable.
COLI also has many drawbacks. Congress recently placed limits on the amount of interest that can be deducted from borrowing from the plan. In addition, only the cash value of the policy with the loans deducted are allowed to be reported on the balance sheets to offset the liability under FASB 106.
Beyond funding the overall health care liability, relatively little attention has been paid to systems for handling the retirement health care problem to minimize actuarial, management and accounting time and costs. Even more critically, no system has been developed to conform corporate accounting/reporting practice to the norms of FASB 106.
In fact, prior systems are solely directed either to reporting pension benefits or for providing actuarial assessments for insurance. Those systems have thus not integrated all phases of a retirement funding program. In sum, there does not appear to be a system available for forecasting, investing, tracking and reporting retirement health care funding program parameters in an efficient integrated system.
A substantial need, therefore, exists for resolving the funding shortfall for retiree health care costs and to reduce the balance sheet risk for corporations. A need also exists for a solution that also plans and manages the liability and asset values and reports the programs, results in compliance with FASB 106.